The weak yen and rising long-term interest rates are not related to increased government bond issuance!

Hirokazu Kobayashi

CEO, Green Insight Japan, Inc.

Professor Emeritus and Visiting Professor, University of Shizuoka

However, the media reports daily that these phenomena are attributable to a decline in international creditworthiness stemming from increased government bond issuance. This misconception is not limited to the media; even AI systems that collect this information provide similar responses. While this theory appeals to household-level intuition, it is a misconception. As of today, Japan's credit default swap (CDS) rates remain at approximately "20 bps," which is among the lowest globally. A CDS is a financial derivative that trades the credit risk (risk of default) of companies or countries, with "bps" (basis points) indicating the credit risk of the subject entity. One bps equals 0.01%. A higher number indicates greater risk and functions like a "credit insurance premium" for government or corporate bonds. In other words, bps fluctuate constantly based on the seller (the party offering insurance) and the buyer (the party purchasing insurance). A low bps value means the market judges the risk to be low; that is, the entity is considered creditworthy. Japan's level is slightly above 20 bps, comparable to EU countries but lower than the U.S. (about 30 bps) and China (about 40 bps). Russia averaged 13,800 bps over five years, while Greece's rose to 25,000 bps in 2012. Therefore, the argument that increased government bond issuance leads to a decline in creditworthiness, causing yen depreciation and rising long-term interest rates, is flawed. On the other hand, "country credit ratings" serve as a measure of an economy's international creditworthiness. While ratings from the three major agencies are well known, some question their objectivity.

How is it that Japan can maintain "low CDS = high creditworthiness" despite increased bond issuance? According to the modern monetary theory (MMT), Japanese government bonds will not default. This theory is rooted in "chartalism," which was first proposed in 1905. It states that sovereign currency-issuing nations with "high creditworthiness" will not default on their bonds. However, this theory does not apply when a country's currency has low creditworthiness, as seen in Argentina's debt crisis from the 1980s to the 1990s and Zimbabwe's hyperinflation and currency collapse in the 2000s. In other words, a currency's creditworthiness is key. Japan's yen is one of the world's three major reserve currencies. Therefore, MMT holds that a large size of the national debt does not determine the risk of fiscal collapse.

So, what causes yen depreciation? Primarily: First, the U.S. has repeatedly raised interest rates, pushing its Treasury rates to 4.25–4.5%. Meanwhile, Japan's policy rate remains low at 0.5%, and other interest rates (long-term and market rates) are also relatively low. Investors buy the high-yielding dollar and sell the low-yielding yen (see figure). This theory is known in economics as the uncovered interest parity (UIP) condition. Additional factors include: (2) Rising energy import costs. Japanese companies need more dollars to pay for imports, so they sell yen to buy dollars. This reduces demand for the yen, weakening it. A minor factor is (3) stock prices and investor sentiment.

Figure: Relationship between increased JGB Issuance and yen weakness / rising long-term interest rates

JGB, Japanese government bond; MMT, modern monetary theory; CDS, credit default swap; UIP, uncovered interest parity; and EPS, earnings per share

Meanwhile, long-term interest rates rose above 1.9% this month. The media argue that increased JGB issuance reduces credibility, implying that higher interest rates are required to attract long-term bond buyers. If this were household debt instead of government bonds, it would indicate a loss of creditworthiness. However, because the Bank of Japan can issue currency, default is unnecessary (MMT). Interest rates reflect policy, supply and demand, and inflation expectations, resulting in rising interest rates. In other words, the framework is as follows: Future growth expectations → popularity (active trading) → rising interest rates. The media's explanation of causality is misguided and grounded in household analogies due to a lack of institutional understanding (see figure). Here, the constraint for households is "repayment capacity," while the constraint for the state is "inflation tolerance." Note that rising policy rates encourage yen buying, leading to yen appreciation. In other words, the Bank of Japan can actively influence the yen's exchange rate by adjusting the policy rate. On the other hand, please note that rising long-term interest rates are a passive response to market movements.